Is this right time to clean up your portfolio?

We have talked over here about many headwinds like slow growth, inflation and European crisis. My prediction number one for this year is that though we had a good start this year, we will face similar or equal challenges what we did last year. Value investors should focus on the things that can impact value of any companies and growth prospects (in its value) while picking up few bargains.

The biggest challenge any investor faces today is to identify any rubbish within their portfolio. Once they do, it is in their interest to get rid off those investments before they damage further your returns.

Recently, after talking to few high net worth investors and institutions I have witnessed people throwing their towel completely from investing in equities after witnessing climatic events and are simply fed up with poor medium term performance and increased volatility.

Nifty 50 has given a return of 27% in last five years and BSE 200 has given returns of 24%. Nifty 50 and BSE 200 also contain rubbish stocks so it is no wonder index has given such pathetic returns. step one is to clean up the portfolio which are rated C1,C2, C3, C4, B3 and B4 and step two is to be ready to buy in quality stocks (A1, A2 and B1) when bargain exists.

This is just one of the many framework and scenario I am operating with and I wonder how long this heightened volatility and poor index performance will transpire. Will investors really exit from equities and will believe in all those advisors offering their own brand of ‘safe’, ‘secure’ and stable investments? On the one hand, I hope so. It would mean certain bargain.

Here is my warning to you all who are looking to give up investing in equities. The time to invest in shares and make good returns is precisely when everyone else isn’t.

The life time opportunity which comes very rare (maybe 2-4 times) to own quality stocks at very cheap price should not be swayed for 20-30% returns and expecting to buy them back when they fall down in future.

If price do fall further – and they could – you need to get ready and will need that extra cash to capitalise on that opportunity. It is not necessary that price will fall to previous lows that were experienced earlier, but the best framework to operate in such conditions is to hold your best buy and liquidate that asset which is not performing and invest them when opportunity emerges to buy quality stocks more.

Rule one: Don’t loose money

The key to slowly and successfully build a portfolio in equities is to avoid loosing money permanently. Sure, good companies will see their price swing but poor companies will see downswing more frequently.

So the easiest way to avoid loosing money is not to buy weak or expensive companies. I have avoided loosing money in my private fund by applying value investing rules that I shared with you all in my previous post.

I have seen many companies on a face value of growing revenues and earnings make large and expensive acquisitions and undertake different projects that are followed by write-downs in couple of years. Write-downs are an admission of a company that they paid too much for an Asset.

When too much is paid for acquisition, or the projects to grow businesses are undertaken, equities go up but profits do not and you can see that in the ratio that I have worked so hard to make popular, return on equity (ROE), is low.

If you look in the market you will find plenty of companies with lower returns compare to even what bank is offering on deposits which have much lower risk. Over time, if these resultant lower returns do not improve, it suggests the price company paid for acquisition was in upper circuit and business equity valuations should be questioned now. If you ask me for the examples of companies in such scenario where they are facing issues to sustain their returns then Reliance Industries and Bharti Airtel are few to name.

When return on equity is very low it suggests the business assets are overvalued on the Balance Sheet. That in turn suggests, the company has not amortised, written down or depreciated its assets fast enough. That means the past historical profits that company announced could be overstated.

These sorts of companies with low returns tend to have a very low- quality score (A3, A4, B3, B4, C1, C2, C3 and C4) by Value operations and also their performance is subdued.

If your portfolio has any shares with such characteristics then you could be at risk because these companies might be very expensive compare to its intrinsic values.

Time is not a friend of poor company. And companies that are rated by Value operations as C4 and C3 are best to avoid if you want best chance to avoid permanent losses. Take a look at the companies in your portfolio; have they issued lots of shares to make acquisition? Are they producing low and single digit returns on their equity? If the answer is yes then you might own ‘C’ Quality Company.

Cleaning up your portfolio not only lowers its risk but will produce cash that may just prove handy in coming months.

Now here is the offer from Value Operations, apart from NBFC and financial stocks, list down 5 companies of which you want to know the quality score in comments below and we will share them all together next week.

Mergers & Acquisitions

40 Comments

Dear Aziz sir, I am listing my five companies (though the list is very exhaustive) along with fundamentals for theit quality score.
1.) AK Capital services is a very interesting company. It is a merchant banker and predominantly active in the Private placement of Debt issues.

For the 8th Consecutive Financial year, AK Capital has emerged as largest mobiliser of debt through private placement of bonds and non convertible debentures during FY 2008-09 (non bank category). Market share of AK Capital in private placement of debt in FY 2008-09 was up by 15.40% to 32.60% as against 17.20% in the FY 2007-08. Source: Annual Report
This is a very interesting market and they are very active and a market leader when it comes to private placement of debt for government institutions. They have also grown very fast in last few years.

The figures are very impressive. This company is quoting at a market cap at 220 crores which seems to be a steal and I hence dug deeper into it. The numbers are also definitely very attractive. It seems to be available at a valuation of 5-6 times earnings.

The company is operating in a wonderful industry which can generate high ROEs for the investor. The average ROE/ROA for the last 10 years has been 20-25%. Their PAT Margin has averaged 30% in last 10 years. The business is easy to understand. The industry is growing at a rate of 10-12% and will keep growing. Placing Government debt is an evergreen function and is not likely to die out as long as the economy has to function, which means forever. The business is also not capital intensive since its a service business. The company will also benefit from two significant trends of this business:
Increasing amount of debt placed and this is expected to continue in the future with corporate bond markets expected to open up. Indian debt markets are extremely undeveloped compared to the developed countries and this situation will change in the future. Link here on a news story.
Increasing amount of Debt placed per issue: This benefits the company because the fixed cost in terms of time spent on a deal is almost same across deals whereas the money generated per deal will be higher with greater deal size i.e. Employee costs for AK Capital will not proportionately increase with the deal size and hence they will benefit significantly from this trend.
These trends are evident from this graph:

However there were multiple issues for me in the annual report and I did not have the competence to evaluate. I hence finally gave it a pass though the company is still in my watch list.

Some issues which cropped up:

– Statutory auditors resigned in 2005-06 and no clear reason was given

– The MD&A revolves a lot around topline growth and how growth in itself is good and does not reflect on usage of capital etc

-The revenues generated from investments are 40% of the total revenues and it is extremely unclear how this business works.

-Significant related subsidiary transactions which I don’t understand once again

-Their cash flow statements are very difficult to comprehend. They have generated only 40 crores in CFO in last 5 years against 95 crores of PAT. They have CFI of -77 crores in 5 years and CFF of +45 crores in 5 years. It is unclear why they are borrowing money and where it is going.

-Their CFO before working capital adjustments in last 4 years is 67 crores whereas post working capital adjustment the CFO is 26 crores. I could not tally the investments in working capital with increases in balance sheet current assets and liabilities. I spent considerable time trying to do the same. Also, I could not figure out why the company needs such huge working capital investments.

-Most importantly, I found certain discrepancies in the cash flow statement and could not account for a reduction in 2 crores in their cash account 2-3 years back. In the 2007-08 Annual Report, the cash and cash equivalents at the end of year is Rs 8,27,70,690 (for the year 2006-07 which has been provided for comparison) whereas if one looks at the Annual Report for the year 2006-07 the cash balance is given as Rs 1,02,770,690. There is a mismatch of Rs 2 crores which can be accounted for by the reduction in CFO of Rs 13,10,000 and reduction in CFI of Rs 1,86,90,000 between the two Annual reports. I.e. For the same year, the figures are different across 2 annual reports and it is extremely unclear why this reduction in cash has taken place. I could not understand this at all. I felt my accounting knowledge was not sufficient enough to figure out these discrepancies. But since I could not call this company to be within my circle of competence when it comes to understanding their AR I felt a wait and watch approach is better. I mailed the company regarding tis 2 crores discrepancy but the reply did not clarify my doubt.

I could not confidently answer how this business is generating money and how it is spending it. Hence, AK Capital Services is a pass as of now. However I will keep this under check since I am extremely attracted towards their core business of debt placements.
2.)
Shakti Pumps is an Indore based manufacturer of various type pumps.Company’s product list includes Stainless steel submersible Pumps,Submersible motors,SH Pumps..etc .Shakti is in the process of setting up a new manufacturing facility to produce booster pumps and it is expected to start commercial production in next month. Company is also planning to start a plant to produce waste water pumps in near future. At present company generating about half of its turnover from exports and the brand is well known for its quality and energy efficiency.Growth in sectors like agriculture,irrigation,sewage treatment..etc are providing growth opportunities for the company.In the financial front company is showing steady growth for the past many quarters.Shakti Pump is one of the high margin pump maker in India.Booster pumps are expected to give a fillip to its bottom line from next financial year onwards.Company is targeting a sale of Rs.200 cr from the newly started booster pump division alone in 2013-14 financial year.For the latest December quarter company posted a turnover of Rs.65 Cr v/s Rs.47 Cr and a net profit of Rs.6 Cr v/s Rs 4 Cr ..Company having an uninterrupted dividend paying track record for the past five years.It also issued bonus shares in the ratio of 1:1 in 2011.In 2010 its share price touched a high of Rs.339/-(Pre bonus) .But due to the exit of a private equity investor, its share price crashed later.For the past few months promoters mopped up huge quantity from the open market which is really a confidence booster.At CMP of of Rs 53/-
3.) As in the case of Tasty Bite one year back ,some companies are
silent performers overlooked by investors and analysts community.
When such a company identified by some strong hands it will move
like rocket and multiplied in few trading sessions. Veljan Denison
seems to be such a company ,unknown to most of the investors.
Veljan is formerly known as Denison Hydraulics . This Company
is located at Hyderabad and promoted by Sri. V C Janardan Rao.
Mr Rao,is a qualified and experienced Engineer with
specialization in the area of Fluid Power.Weljan has promoted
with technical and financial assistance of Abex Corporation,
USA .In 1987 parent company ie, Abex corporation transferred
their interest in the Hydraulic Division to M/s. AB Hagglund & Soner
of Sweden and since then the Hydraulic Division came to be know
as Hagglunds Denison worldwide .This Swedish company is still
holding 13% shares in Veljan through Incentive Fastighet A B.
Indian promoter is holding 73.10% stake .This makes the total
promoter holding is 86.1% in this tiny capital company with total
capital of just 1.8 crore.This low equity base may be a reason
for the overlooking of investors towards this wonderful company.
Later the name of Indian company changed to Veljan Denison to
reflect the interest of Indian promoter too .

Denison is a well known name in hydraulic Industry. Its products span across Hydraulic Valves,Cylinders,Vane pumps and Pneumatic equipments.In reality this small company is the only one listed player offering a product list of more than 200 products related with hydraulic and pneumatic sectors.We may have another listed players like Kirloskar pneumatic,Atlas Copco,Yuken India,Dynamatic technologies ..etc making these type of products .But none of this single company offering this much products under single fold.Company is producing these products from its three manufacturing units in an around Hyderabad.Veljan has its own in-house R & D for product development , enhancement and expansion of product range.Growth of company’s products are closely related with the growth in industrialization. After a not so good year due to recession ,now company is returned to strong growth path.Company’s Financial year ending is in September.Last FY ,Veljan posted a turnover of Rs.41 crore net profit of Rs.4.46 Cr.and an EPS of Rs.26/- .After this bad performance of last year now in half year March itself company already posted an EPS of Rs.20/-. In march qtr itself Veljan posted an EPS of Rs.11/- v/s Rs.3/- in last year same qtr.In September full year it is expected to post an EPS more than Rs.50/-.Notable point is that ,company’s performance is improving steadily in each year(except last year).Company also increasing dividend payout and last year paid 50%on FV 10 shares.Its share price is now ruling around Rs. 375.Five year high is Rs.1044/ – touched in 2007 and lowest is Rs.160/- in last bear phase of 2009.Even from current level this may surprise,which is now trading at a P/E of 7 to the expected full year EPS v/s industrial average P/E of 30.
4.) From the tea pack I am selecting one company which is not so familiar for many of you – Rossell India Ltd.There is many other companies in this sector but I feels this company’s diversification plans makes it more attractive than other companies from the same sector.
Company having Five tea estates in Assam in an area of 4000 hectares.For the last financial year Rossell posted a turnover of Rs.80 Cr and a net profit of Rs.18 Cr EPS is Rs.5/- ( FV Rs,2 Shares). In addition to the conventional Tea business company having two more divisions- Aerospace/defense , and Hospitality. Potential of these sectors differentiate this company from other tea companies.Under the Bangalore headquartered Aerospace and defense division – Rossell Techsys- company is offering services like custom embedded systems product design and development, product support services including Installation, testing, commissioning and maintenance, test solutions including test jigs, rigs, and simulators etc , and wire harness engineering and looming.Company representing many foreign companies like MacSema in India for their various products and services in Aerospace and defense.This division having an approximate employee strength of 70.

Recently company started a hospitality division to increase its presence in this sector.It is a point to note that company already having some experience in this field through their strategic investments in a company which is running the franchise of ‘YUM'( owners of brands like KFC, Pizza Hut, and Taco Bell) in Nigeria.Few months before Rossell decided to start fast food chains in various cities in India too .It is not clear at this point that whether this is through a master franchise agreement of any well known brands or not.Anyway their previous experience in this field will be an added advantage.Apart from this ,company also having some interest in Lemon Tree Hotels which is running 12 hotel properties across India.

Company’s share price is currently trading at Rs.40 /- with a P/E of 6 on the expected full year EPS of Rs.7/-. Considering the chances of an improvement in Tea prices, it is at the lower level .If the upcoming fast food chain venture turn as a success and defense and aerospace division posts decent growth after the expected opening of private sector in defense , this unknown stock may be re rated sharply. Only on the valuation of Tea division itself it is a better pick from the tea pack @ Rs.38/-
5.) J. Kumar Infraprojects Limited operates as a civil engineering and infrastructure development company. The Company focuses on the development of roads, flyovers, bridges, railway buildings, sports complexes and airport runways. J. Kumar also undertakes foundation work using hydraulic piling for major projects.

J. Kumar Infraprojects is a decent bet in small-cap infra space. Its currently trading at a P/E of less than 7 with good dividend yields of well over 1% in the last 12 months. The company runs at a debt of 167 Crores, with cash in hand of 47 Crores. Revenues have risen sharply from 214 Crores to 946 Crores in the last 4 years. Profits have risen from 20 Crores to 72 Crores in the last 4 years. NPM has dipped from over 9% to less than 8% over 4 years.

I am the editorial in charge/moderator for Valueoperation.com, I like your enthusiasm on sharing the knowledge.
Several of our regular readers have given a feedback that your comments are lengthy and going away from the topic for that blog entry. I am more than happy to offer you a guest blog entry as and when you would like to share some good findings with valueoperations readers.

Also as point out by those readers comments sections for each blog entry is for discussion purpose only, I please request to keep posting in comments to max of couple of paragraph only.

Dear Mr Chirag,
I promise to check myself in future. Now, coming to the point, I would like to put a question on Omnitech Infosolutions which has good financial parameters. With hardly a years earnings in debt, why is the promoters stake decreasing on a quarterly basis. Did I miss seeing something and/or what other things can compel the promoters of an otherwise profitable company to decrease their share holding ? Does it fall into the A1 category of stocks given the present fall in price?

Dear Appa Rao,
Omnitech Infosolutions has a rating of ‘A2’ and I won’t be suprised if it slides down to ‘B2’ after March 2012 results. Again Quality and Performance ratings have no impact on its ‘price’ performance in the market. They are independent to price fluctuations similar to Values.
Omnitech Infosolutions does not meet our criteria to invest (for our private fund) but I can share few things where we are struggling. We have not able to identify ‘Competitive Advantage’ that can sustain it’s high ROE. Though this company is profitable I am not happy with its cash flow from last 4 years. It looks they have habbit of spending more than what they earn.

Thanks Nageshwa,
Let me take this opportunity to put more light on Quality and Performance ratings. Quality ratings (A,B,C) are updated twice in a year and their performance (1,2,3 and 4) every quarter. Will get back to you with ratings next week for your requested companies.

Dear Aziz sir! A long wait for your portfolio is weighing down heavily on me. I am referring to your statement in the above article ” Here is my warning to you all who are looking to give up investing in equities. The time to invest in shares and make good returns is precisely when everyone else isn’t.” I think me and many others like me are being victims of emotional overinvestment. Emotional overinvestment is a state where one leans towards doing irrational things under the weight of the time and effort invested in supporting that same irrational act. As a student of value investing, I too have been a victim of it. Researching every stock, however good or bad, takes time and effort. To make matters worse, it also has an element of opportunity cost attached to it. In a bid to find that one hidden gem, I run the danger of picking a weak stock just because of the ’emotional investment’ I put into the research of it.
Today, even as the market touches 17,600 points on the BSE, we might still see some value buys. Every value investor must be vary of the perils of emotional overinvestment as they runs their numbers in annual reports, moneycontrol e.t.c on the Internet. Its easy to make a mistake, almost impossible to rectify it.
In conclusion, I am reminded of a line in the movie “Syriana” where one of the attorney says – “When they write the GAAP like abstract art … you look at a liability long enough and it’ll start looking like an asset”.
Waiting for your prized portfolio in all eagerness – Good luck.

Well said Mr. Appa Rao. All this time spent research stocks does indeed create an emotional attachment to them and sometime this lead us to invest in weak stocks.

I have faced similar dilemma. Now I apply the following mental constructs/model to by pass this very same feeling.

One is having an attitude of long term. I don’t see stocks to return substantial returns in short duration. They are more like real estate. Buy some prime and good location real estate and wait. My aim is to build a long term fruit bearing portfolio and that needs time. This lets me ignore noise that all around the market.

Never buy in one lot. Stagger the purchases. This has saved me in getting out of weak opportunities that I just went in due to emotional attachment and the noise. Patience is the single most important ingredient needed for investment success.

Having a simple framework that helps rationally analyze a business without any attachment to the price. I have created a little excel sheet where I just monitor 3 or 4 variables of financial health like debt to equity, cash flow, Business Margins and Return on Equity. If the new business I am analyzing fails this excel test, I don’t invest more time in analyzing the stock. If in doubt I make a point to visit the business each quarter to reevaluate.

I never look at the future prospect of a business first. That’s the most important thing but that should be checked last. If seen in the beginning, it will cloud our decisions. First see the history and if the long term and the near term history is stable and with out suspicion. Only if the past looks stable, invest more time into the stock

Sukhbinderji,
I don’t think it is possible to quantify everything
A car might have a top speed of 160 kmph. It could do 0 – 100 kmph in 12 seconds. It could have the biggest boot, large number of gadgets and good rear space. And hey, it could be the least expensive car and have the highest fuel economy too.
But that does not automatically make it the best car to buy.
You still need to sit in car and see how comfortable the ride comfort is. You still need to like the looks of the car and the interior quality. The engine should feel refined and the gearshift should be smooth. And yes, you still need to consider how good the service network is before you decide on the best car.
The mathematical model is just a guide to help one decide. According to me, it does about 75% of the job of finding the best and the worst stock to buy at current market prices, in a given set of stocks.
a good dividend yield may not be good since it implies management does not know how to utilize reserves
The idea is to reward companies (with points) which payout large dividends but still manage to grow at 50 or 60% CAGR. That goes against the usual old school belief that all dividend yield stocks are slow growers. And exactly here comes some disconnect between your analysis and conviction.
Hoping to out grow from doubts and more doubts with inputs from one and all – GOOD LUCK.

Stocks with consistently high return on equity have a better probability to outperform the market
It is fashionable during a market downturn to announce that stocks are available at attractive valuation. The various exhibits displayed to justify the proposition include P/E, BV and dividend yield. Another oft quoted currency is return on equity (ROE). The belief is that the market favors companies generation high ROE.
Take for instance, Cummins India. The stock has consistently outperformed the overall market in calendar years 2006, 2007,2008, 2009 and 2010. The maker of diesel and natural gas engines gained 392% compared with the BSE Sensex, the bench markequity index, which returned 118.2% between30 December 2005 and 31 December2010.
The clues to Cummin India’s marketperformance can be found in its financials.The stock has delivered superior ROE overthe last five years. Its ROE stood at 35.1%in 2010-11, 30% in 2009-10, 34.7% in2008-09, 27.6% in 2007-08 and 28.2% in2006-07%. Moreover, it is almost debt-free,with loan of mere Rs 18.2 crore against shareholders’ fund of Rs 1806.2 crore.
Two other companies have outperformed the Sensex in each of the last five years. Thes eare Gruh Finance, which has delivered point to-point return of 468.7%, and Pidilite Industries,with a return of 271.4% between2005 and 2010. In both these cases, ROE ison the higher side. Gruh Finance’s ROE is inthe range of 23.6% and 31.4% in the last fiveyears. Pidilite Industries has posted ROEbetween 21.3% and 34.6%.
Among the various financial ratios thatare considered important to evaluate stocksfor investment, ROE is one of the most important.
ROE is determined as net profit upon shareholders’ fund.
Net profit refers to profit after tax minus preference dividend,if any.
Similarly, preference share capital is deducted from shareholders’ fund.
Shareholders’ fund basically has two components: equity share capital and
reserves and surplus.
This is done to calculate returns generated on funds invested by the equity shareholders in a company.
Preference share capital carries a pre determined and fixed dividend.
It is not completely a risk capital. Preference shareholders get precedence over equity shareholders in redemption of their shares if a company goes into liquidation.
A high RoE, expressed in percentage terms, reflects superior returns generated by the company. This ratio is also known as return on net worth (RONW).
ROE of various players in an industry can be compared to determine who is better within the business.
Investors can have a look at ROE of companies across industries to arrive at sectors that can generate better ROE.This even helps investors to churn their portfolio,and move to stocks with higher ROE.
A gradual or year on year gain in ROE is an indicator of improving efficiency in utilisation of equity capital.
It shows the management is making good use of money entrusted to it by equity shareholders.
Castrol India has reported increase in ROEin each of the last four years. The company’s ROE stood at 93.5% in the year ended 31December 2010 compared with 78.5% in2009, 57.9% in 2008, 51.5% in 2007 and38.2% in 2006.However, such improvement is exceptional.Investors instead could focus on stocks with lower volatility in ROE and improvement in ROE over a shorter period.
Companies to have seen increase in ROE over the last two years include VST Industries,TTK Prestige, Ador Fontech, WendtIndia, Titan Industries, ITC, Gruh Finance,Grindwell Norton, Glaxo Smith Consumer Healthcare, City Union Bank, and Surana Corporation.
I checked around 2,800companies listed on the Bombay Stock Exchange(BSE) to pick companies with superior ROE. For this, companies with market capitalisation of over Rs 100 crore were selected. Only those companies whose latest financial results were available were taken into account.
The median ROE for all these companiesin each of the last five years was determined.
Only those companies that had generatedabove median ROE in each of the lastfive years were shortlisted.
This way, greater significance was attributed to companies with consistent track record of profit and also generating higher ROE.
At the end there were 85 companies (see googledocs file CM High ROE Stocks v26i13
As only profit-making companies in each year were included, the median ROE for each year is on the higher side.
In that sense, these85 companies outperforming the median ROE in each of the last five years is commendable.
The median ROE for companies stood at 18.3% in 2010-11, 19.4% in 2009-10, 18.2% in 2008-09, 21.7% in 2007-08 and20.9% in 2006-07.
Internationally, ROE of15% is considered as a benchmark.
All these85 companies are well above this threshold.
The chief drawback of the filter is that turnaround stocks are left out.
Turn around stocks could deliver superior returns. This is because consistency in ROE varies.
Out of these 85 companies, 23 belong to the large-cap category (market cap Rs10000 crore and above),
44 are from the mid-cap category (market cap between Rs500 crore to Rs 10000 crore), and
the remaining18 are from the small-cap category(market cap below Rs 500 crore).
Out of these 85 stocks, 63 stocks have outperformed the Sensex, which reported again of 118.2% on point-to-point return between2010 and 2005.
This means 74% of the companies with consistently high ROE over the last five years have managed to outperformthe overall market. The bottom lineis companies with consistently higher ROEhave the potential to deliver better returns.
In the current calendar year, 75%, or64 companies, of the 85 beat the market between the BSE closing on 26 July 2011and 31 December 2010. The Sensex lost9.7% in this period.
The prominent gainers in 2011 so farinclude Elantas Beck (23.2%), VST Industries(99.1%), TTK Prestige (90.3%),Ador Fontech (82.7%), Wendt India(54.4%), Hawkins Cookers (50.2%),CRISIL (39%), Novartis India (37.9%)and Foseco India (36.5%).
The star performers in the large-cap category based on stock market performance between 2005 and 2010 comprised Exide Industries (558.5%), Sesa Goa (548.8%),Lupin (526.5%), Hindustan Zinc (457.6%),Asian Paints (397.9%), Crompton Greaves(393.2%), and Cummins India (392.6%).The gain is based on the BSE closing as on31 December 2010 compared with closingas on 30 December 2005.
Among mid-cap companies, the biggest gainers were Hawkins Cookers (1756%),TTK Prestige (1171.8%), Coromandel International(790%), Amara Raja Batteries(643.1%), City Union Bank (537%), BajajElectrical (473.2%), GRUH Finance(468.7%), CMC (464%), Thermax(359.3%), and Areva T&D (357.8%).
Among small-cap companies Bliss GVSPharma (1706.3%), Muthoot Capital Services(1073.8%), Ashiana Housing(703.4%), VST Tillers Tractors (514%), andGujarat Reclaim (473%) emerged at the top.
The trends emerging from the ROE toppers reveal certain interesting facts. Out of these 85 companies, 26 are debt-free. The prominent debt-free companies include Infosys, Hindustan Unilever, GlaxoSmith Consumer Health, Crisil, Abbott India,Alfa Laval, Castrol India, Nestle India, andP&G Hygiene.
Further, 15 companies have negligible debt (less than 2% of total shareholders’ fund). Colgate Palmolive, Novartis India,Siemens, Hindustan Zinc, Exide Industries,Wyeth, Glaxosmit Pharma, Crompton Greaves, Cummins India, TCS and ITC are among the companies with insignificant debt.
Companies from industries such as pharmaceuticals(11), personal care (6), chemicals(5), software (5), engineering (4), and finance & investment (4) dominate the list of 85 companies with consistently high ROE.
Another trend is that many companies command rich valuations. For instance, 20companies’ P/E is in excess of 30. Another20 companies’ P/E is in the range between20 and 30. Astrazeneca Pharma (54.8),Elantas Beck (53.3), P&G Hygiene (50.2),Titan Industries (47.2), and Nestle India (47)are the most expensive stocks.
The recent market carnage offers good opportunity to investors to pick stocks with consistently higher ROE as several stock shave reported sharp correction. These includeCrompton Greaves (-43.6%), JyotiStructures (-35%), Voltas (-34.2%), BlueStar (-33.9%), and Thermax (-31.5%).
ROE has certain drawbacks. It providesno hint about debt levels. Equity could below, pushing the company to borrow to fundits business growth. Borrowing could begood way to finance growth when marketconditions are robust. But in difficult timeshigh debt could put companies in trouble ifprofitability dips. Interest cost is mostlyfixed and would not decline in case of slowdownin business.
For instance, Balaji Amines has a debt-to-equityratio of 1.4 times, with debt of Rs165.4 crore compared with shareholders’fund of Rs 112.4 crore on 31 March 2011.The stock has underperformed the marketin the current calendar year so far.
Anotherexample is Jyoti Structures, which hasunderperformed the market. Its debt-to-equityratio stood at 0.8, with debt of Rs 476.6crore as against equity of Rs 576.1 crore.So like all other parameters, ROEshould not be viewed in isolation but consideredas one of the checklists to shortlistor validate a stock’s selection for inclusionin the portfolio.

Indian investors tend to put their money on stocks more for their ability to deliver capital gains than for their yearly dividend payouts. This is also justified by the fact the Indian market as a whole doesn’t deliver much of a return by way of dividend.
The current dividend yield for the constituents of the Nifty index (dividends/market price) is less than 1 per cent. Nevertheless, investing for dividends does make sense for investors due to a few reasons. If last year’s evidence is anything to go by, dividend payouts tend to be less volatile than company profits, which decide valuations. While the market as a whole may not sport a high dividend yield, investors can still bet on the few stocks that do. Here’s an analysis of the trends in dividend payouts of Indian companies and dividend yield stocks, based on a study of the CNX 500 stocks.
Less volatile:
Despite 2008-09 being one of the worst years in recent times for the Indian economy and its companies, the latter did not materially cut back on dividend payouts. Even as the overall net profit of the CNX 500 companies dipped by 6 per cent between 2007-08 and 2008-09, their total dividend payout saw only a 2 per cent dip, falling to Rs 52,500 crore from the Rs 53,360 crore in FY08.
The overall dividend payout ratio actually edged up a little from 24 to 24.8 per cent, as companies dug deeper into their pockets to pay dividends. The number of companies that declared dividends in 2008-09 was 364, just 17 short of the previous year.
Quite a few of the companies that paid dividends last year maintained their dividend rates despite a fall in net profits — Amtek India, Godrej Industries, Jindal Saw, Nirma and Tata Chemicals being some instances. Tata Steel maintained its dividend rate at 160 per cent despite a small 10 per cent growth in its standalone profits. The message to investors is that dividend payouts may be less volatile than per-share earnings. During a downturn, this makes it preferable for investors to bet on dividend paying companies rather than non dividend payers.
Consistent payers:
Investors looking for consistent dividend payers over the long term however may not have too many stocks to choose from. Scanning through the CNX 500 companies throws up a few names — Neyveli Lignite, Chambal Fertilisers, Hero Honda Motors, Geometric, Havells India and Elder Pharma.
The trick in identifying consistent dividend-paying companies seems to be low payout ratio. Most companies with a regular payout appear to have set a record of consistency by paying a limited share of profits as dividends; payout ratio has been less than 30 per cent in eleven of these companies.
Elder Pharma has been declaring 25 per cent dividend every year in the last five years. But this is just 9-12 per cent of its profits. Geometric has been declaring 40 per cent dividends which are again just 10-20 per cent of its profits. A low payout ratio probably allows dividend-paying companies to maintain the payments even through ups and downs in earnings over the years.
Higher stock valuation?
If dividends and capital gains are the two components of return to an investor, how much do Indian investors value dividends? Not much, it seems. The market doesn’t actually give higher valuation to companies that pay out consistent or high dividends. Hero Honda Motors with an annual dividend Rs 20 per share, for example, has never traded at valuations higher than TVS Motor (whose dividends have fallen from Rs 1.30 per share to 70 paise per share) in the last five years.
Tata Chemicals (dividend per share risen to Rs 9/share from Rs 6.5 five years back) has been trading at lower valuations compared to RCF (dividend per share Rs 1.70-1.20); State Bank of India too (dividend per share up from Rs 12.5 to Rs 29) has been trading at a lower PE than HDFC Bank (dividend per share Rs 10, up from Rs 4.5).
The markets also don’t seem to mark down a stock’s valuations when dividends are cut or don’t materialise for a particular year. For example, JSW Steel’s dividends dropped sharper than that of SAIL in FY09 but the market continued to give it a higher PE than the latter.
Given that valuations are a function of a company’s perceived “growth” potential, markets appear to value companies that plough back profits into the business better than those that pay out dividends. This means that if you are a dividend seeking investor, you may actually find your stocks trading at a valuation discount to peers.
Dividend yield stocks
Turning from dividend payouts to dividend yield (dividends as a proportion of stock price), though the index’s average yield is low, there are a handful of stocks in the CNX 500 that have consistently delivered high yields to investors; with dividends rising in proportion to the market price of the share.
Some stocks that have consistently delivered a 3-7 per cent yield every year over the last five years are Supreme Industries, Karur Vysya Bank, Wyeth, Nava Bharat Ventures, Supreme Petrochemicals, LIC Housing Finance and Andhra Bank. In some of these cases, the high dividend yield made up for the capital loss in the stock during the 2008 meltdown.
In the case of Wyeth for example, dividends added 8.17 per cent (Rs 37/share) in FY09 to the returns of investors who had bought the share a year ago. This almost made up for the loss in the value of the share (Rs 38/share) in that period on crash in the stock market. However, investors basing their decision mainly on a stock’s historic dividend to get at the yield may at times be misled by companies cutting back on dividends or reducing payouts after exceptional years. Someone who invested in Indo Rama Synthetics in March 2008 looking at its attractive 13.5 per cent dividend yield was likely to have been disappointed the following year. With the company reporting a loss of over Rs 90 crore on a fall in sales and spike in interest cost the next, it didn’t declare dividends at all.
In the case of Monsanto India, the company’s one-off dividends of Rs 297/share in 2007-08 lifted the dividend ‘yield’ to very high levels; but dividends normalised the very next year to Rs 25/share. Another instance of a company making a large payout due to one-time income was EID Parry which declared a 1000 per cent dividend in FY09 out of windfall profits on sale of investments. This however may not be the case in the current year.
An unusually high dividend yield may also be a direct reflection of the low valuations that the market is willing to grant a particular stock due to uncertainties surrounding the business.
Findings so far suggest three key takeaways for dividend seeking investors:
Dividends for the more consistent companies may be less volatile than their profits;
Look for a low payout ratio if you seek consistent dividends; and
Beware of one-off payments while determining yield.
Finally, are there any specific sectors that investors can look to, to unearth high dividend yield stocks? Investors though don’t have too many choices. But fertiliser makers and banks seem to figure more often on the list of dividend yielding stocks.

Dear Appa Rao, could you please share the total list of 80 plus companies with avg ROE of the companies. Actually I am looking for myself the full list and I am able to find some but want to have full list of these companies for my further study. Thanks in advance.

Dear Mr Nageswa, Please spare some time to give my detailed list. In the mean time – track savita oil , abc bearings , ador fontech , vesuvius india , ZF steering ; all have strong financial statements with some having great div payout as well as great div yield

“I checked around 2,800companies listed on the Bombay Stock Exchange(BSE) to pick companies with superior ROE. For this, companies with market capitalisation of over Rs 100 crore were selected. Only those companies whose latest financial results were available were taken into account.
The median ROE for all these companiesin each of the last five years was determined.
Only those companies that had generatedabove median ROE in each of the lastfive years were shortlisted.
This way, greater significance was attributed to companies with consistent track record of profit and also generating higher ROE.
At the end there were 85 companies (see googledocs file CM High ROE Stocks v26i13
As only profit-making companies in each year were included, the median ROE for each year is on the higher side.
In that sense, these 85 companies outperforming the median ROE in each of the last five years is commendable.”

I am looking for these 85 companies full list. If available you may provide the same and if not available also, no problem as major companies of 85 companies are covered in your post. Anyway thanks for efforts and time.

Most of us might have faced a dilemma whether to buy the Industry leader or its nearest competitor. So lets take a look at historical returns over three years as these include 14 months of Bear market. Stock returns reflect how management of both the leader and its nearest competitor faced the global recessionary environment. I have excluded Tata Steel v/s SAIL comparison as the former has a global presence while the later is restricted to India, RIL v/s ONGC due to govt. intervention in the operation of ONGC, Sun Pharma v/s Cipla due to FDA issues at the former’s subsidiary.

The gap between both the stocks returns are huge with Bharti Airtel delivering 10% returns while RCOM with a negative returns of 57%. The problem with all the ADAG companies are their focus on market share rather than profitability.

DLF v/s Unitech

Unitech’s returns were 2 times the DLF on the downside with -67% compared to -33% of DLF.

Hero Honda v/s Bajaj Auto

Inspite of losing market share to Hero Honda, Bajaj Auto’s stock has done relatively better with 185% returns compared to 112% from the leader’s stock, since it was listed after its demerger of various businesses on 26/05/08.

Voltas v/s Blue Star

Blue Star did much better than Voltas with 101% returns compared to 59% from the later. Blue Star’s focus on return ratios did the trick for them.

Exide v/s Amara Raja Batteries

Amara Raja Batteries did relatively better than Exide with 216% returns while the later delivered 197% returns. I guess Exide’s underperformence was due to its loss making life insurance business.

Welspun Gujarat v/s Jindal Saw

The leader delivered a return of 215% compared to its nearest competitor (Jindal Saw) returns of 149% over the last three years.

Conclusion: Its divided here with the leader doing relatively better to its competitor in 4 out of the 9 cases. So buying the second largest player may sometimes be the better option than the industry/segment leader.

Dear Mr Nageswa,
With the Indian stock market threatening to head to September 2008 levels, investors will not be blamed for asking the question: Buy now – or run away?
Investors buy (or sell) the earnings. Traders buy (or sell) the news flow.

I have little advice for traders since I don’t really track global – or local – markets on a minute-by-minute or even hourly basis. But for investors, I will continue to offer the comfort that India’s GDP is growing well and will stay above 7% per annum for the next decade based on a vibrancy that is not dependent on the support of government. Yes, the Indian economy could grow by 8% or 10% but for that we need political parties that shed their arrogance and really work for the country. But, that is not likely, so let’s not waste time over that hope!

And where there is growth in the economy, there is growth in earnings.

The markets are currently in “trading mode” driven more by fear and less by greed. Long term fundamentals are being ignored and short term fears and prejudices have taken over. In a rational world, investors would follow the trend of long term earnings. Based on the outlook for growth and earnings, India would be allocated more capital than the western world .
For investors, building a portfolio, my recommendation remains to keep buying – recognising the impact of weak inflows on the prices of Indian shares. Please remember that markets can turn on a dime. Sentiment – for better or for worse – can change overnight. Fear can quickly turn into greed.
There is no fundamental change in the earnings direction of Indian companies as a universe. There is no flaw in the argument that foreign money will come into India – the unknown is the timing.
A combination of earnings growth and foreign inflows could see the market surge. A 28,000 Index level in 2012 may sound lofty from where we are.
Would I be upset – or wrong – if the 28,000 level was not breached in 8 months?

Wrong, yes; but upset, no. Not if the reason for the failure to reach was lack of foreign flows.

As long as there is visibility of earnings growth in Indian companies, I am investing in the stock markets And I have kept aside money for many months of monthly family and living maintenance to tide me over tough times.

When I reap the reward of my investment in equity mutual funds is an unknown – that is what the traders with a really short term time horizon will worry about. Investors stay invested for the long haul as long as there risk-return needs and their personal situation of an immediate need for money have not changed.

And by the way, if you are buying shares with a “target” of 28,000 on the BSE 30 Index in 2012, then you are not an investor – but a trader! Because, if earnings keep growing – and I use the estimates of the hundreds of research analysts here – there is a case for the Index and share prices to keep doubling every 6 or 7 years! The only reason I would exit the stock market – or change my portfolio mix – would be if the outlook on earnings changed, if the markets got “expensive”, or if I had a need for the money invested.

mayur uniquoters
has a good product and excellent cliete(bata,liberty,khadims,honda,maruti,tata motors)
balance sheet is good
equity not diluted
loans in control
sales have increased 5 times in 5 years
cash flow is good
ROE and ROC has incresed consistently…
drawbacks are
family run business
eps growth drecreased significantantly in the current year.

ZF steering
in auto industry i prefer auto ancilleries like fag bearings,zf steering more than auto companies like maruti,tata motors and bajaj…i hold only hero motors.

zf steering again is good product,professional management,good cliente.
balance sheet is good
sales and operating profit is good
excellent NPM,ROE,ROC.

drawback
current year eps growth is significantly less than previous 2 years.

Krishna,
Could you find out why ROE had fallen significantly of Mayur? and also reason on whyEPS growth is significantly less for ZF Steering.
Was it dilution of equity or revenues had fallen down….
The best way is to find the competitive advantage of both the companies.. do you see that in any of those companies?
Email me your research at aziz@valueoperations.com in context too:
1. What do you think or basis of strong long term prospects of the company.
2. Do they generate high Returns (ROE) and have you found the competitive advantage that can sustain those returns.
3. What are the debt levels
4. Do they have surplus cash flow
5. What do you think about management.
I am sure this framework will help you to take decision on investment. If you still struggle then let me know where you got stuck and I will help you.

Hi Krishna,
My source of information was through their 2011 Annual reports and their quaterly results that I had glance.
In March 11 they reported 25.27 Crore on their investments of 61.01 Crore. (To calculate ROE we take average Networth of March 11 and March 10 (61.01+42.05/2). This will give 49% as ROE.
Now for March 2012 my expectations of Networth is in range of Rs 81 – 85 Crore. If we take average of March 12 & 11 networth ( 81+61.01/2) will give us Rs 71.01 Crore. 49% of that will be Rs 34.79 Crore.
They have reported profits for 9 months Rs 22.20 Crore. Do you think they will be able to make 34.79 Crore this year? I don’t think so. What I take from this scenario is that this business is not growing to the expectations of their ‘Implied growth rate’. There could be many reasons for this, for example management is retaining profits more than they should back in business. Could be the profit margins or because of tough competition they are not able to grow their revenues. Try to find out the reasons why their proftability is falling down.
Let me know if you get stuck anywhere.

Hi Nitin,
Thanks for your participation on our blog.
Goa Carbon is rated as ‘C4’ quality company by Value Operations. It is not an investment quality grade. They are in debts, earnings are ordinary (ROE) and are burning cash if you look at the cash flow.
Hope this information helps you. Looking forward for your participation in future…